ACC450 - Chapter 17
Situation: Bowles Company is engaged in a hazardous trade and has obtained insurance coverage related to the hazard. Although the likelihood is remote, a material portion of the company's assets could be destroyed by a serious accident.
Unmodified standard
Situation: The auditors decide not to make reference to the report of a component auditor that audited a portion of group financial statements.
Unmodified standard
The primary responsibility for the adequacy of disclosure in the financial statements of a publicly-held company rests with the:
management of the company.
A material departure from generally accepted accounting principles will result in auditor consideration of:
Whether to issue an adverse opinion rather than a qualified opinion (When the auditors take exception to the application of accounting principles in the client's financial statements, they will issue either a qualified or adverse opinion, depending on whether the misstatement is considered pervasive.)
Scenario: A company has changed the remaining life of a significant asset from 12 to 10 years. You believe that the change is reasonable.
Circumstance: Consistency or None Type of Opinion(s): Unmodified Report Alteration: No alteration
Situation: A client changed its depreciation method for production equipment from the straight-line method to the units-of-production method based on hours of utilization. The auditor concurs with the change.
Unmodified with an Emphasis of Matter Paragraph
Situation: A client's financial statements follow GAAP, but the auditor wishes to emphasize in his audit report a significant related-party transaction that is adequately described in the notes to the financial statements.
Unmodified with an Emphasis of Matter Paragraph
What date is ordinarily used to date an audit report?
Last day of field work
A client company has changed its accounting practices during the year, materially affecting its financial statements so as to make them seriously misleading and not in conformity with generally accepted accounting principles. The CPAs examining these financial statements should:
render an adverse opinion and give reasons.
Upon the advice of its auditors, Smith Company changed the method of computing depreciation from the straight-line method to an accelerated method with a material effect upon the financial statements. The auditors' report:
should include an additional emphasis-of-matter paragraph highlighting the accounting change.
Which of the following is not an acceptable financial reporting framework?
Generally accepted auditing standards basis.
What are the types of audit reports for uncertainties?
Lawsuits: -Unmodified with Emphasis of Matter -Disclaimer
What type or types of audit opinion are appropriate when financial statements are materially and pervasively misstated?
Qualified - No Adverse - Yes (When a misstatement is pervasive, an adverse opinion is appropriate.)
What type of report(s) arises due to a scope limitation?
Qualified or Disclaimer
Situation: A client omits a note disclosure related to significant accounting policies that the auditor believes to be fundamental to users' understanding of the financial statements.
Adverse
When an adverse opinion is expressed, the opinion paragraph should include a direct reference to:
a separate paragraph that discusses the basis for the opinion expressed.
Situation: A company has not followed generally accepted accounting principles in the recording of its leases.
Qualified or Adverse
What circumstance(s) result in a disclaimer of opinion?
-Large Scope Limitation -Uncertainty Situation (Lawsuit) -Going Concern
In a "going concern modification" an auditor evaluates whether there is "substantial doubt" about an entity's ability to continue as a going concern for a reasonable period of time. How long is this reasonable period of time?
1 year
Assume that the opinion paragraph of an auditors' report begins as follows: "With the explanation given in Note 6, ... the financial statements referred to above present fairly..." This is:
An improper type of reporting. (This phrase violates the fourth standard of reporting, because it does not give the reader of the report a clear-cut indication of the auditors' opinion. The phrase appears to modify the standard opinion paragraph, but is not forceful enough to constitute qualifying language.)
The auditors' report should be dated as of the date the:
Auditors have accumulated sufficient evidence (The audit report should be dated no earlier than when the auditors have accumulated sufficient appropriate evidence. This date is often the last day of fieldwork.)
Scenario: A company changes from FIFO to LIFO for inventory valuation and you concur with the change. The change has an immaterial effect on the entity's financial statements this year, but it is expected to have a material effect in the future.
Circumstance: Consistency Type of Opinion(s): Unmodified Report Alteration: No alteration
Situation: A client changed the depreciable life of certain assets from 10 years to 12 years. The auditor concurs with the change.
Standard Unmodified
Situation: A company has not followed generally accepted accounting principles in the recording of its leases. The amounts involved are immaterial.
Standard Unmodified
Situation: A component auditor has audited a subsidiary of your client as a part of a group audit. You have decided to rely upon the component auditor's work.
Standard Unmodified
A scope restriction is least likely to result in a(an):
Adverse Opinion
What's the difference between "component auditors" and a "predecessor auditor"?
Component: used as part of group audit Predecessor: fired auditor
Under which of the following circumstances would a disclaimer of opinion NOT be appropriate?
management does not provide reasonable justification for a change in the accounting system
Under what circumstance(s) is an adverse opinion issued?
Departures from GAAP (severe, pervasive, etc.)
What types of reports are issued when "component auditors" are involved?
Modifying Existing Paragraph: no responsibility Unmodified: taking responsibility
Situation: A client changed the salvage value of certain assets from 5% to 10% of original cost. The auditor concurs with the change.
Standard Unmodified
The auditors who wish to draw reader attention to a financial statement note disclosure on significant transactions with related parties should disclose this fact in:
An emphasis-of-matter paragraph to the auditors' report. (The auditor communicates through the auditors' report and therefore only answer (1) is correct. Note that the client will include a discussion of the related party transactions in a note to the financial statements.)
Which of the following ordinarily involves the addition of an emphasis-of-matter paragraph to an audit report?
A consistency modification. (A consistency modification results in an emphasis-of-matter paragraph. Qualified and adverse opinions include a basis for modification paragraph. When a report refers to component auditors no additional paragraph is added.)
Which of the following is least likely to result in inclusion of an emphasis-of-matter paragraph in an audit report?
A decision not to confirm accounts receivable. (An emphasis-of-matter paragraph is appropriate when an auditor wishes to emphasize a matter concerning the financial statements, but not a matter concerning the scope of the audit engagement. Accordingly, answer (3) is not a situation in which an emphasis-of-matter paragraph is appropriate since confirming accounts receivable relates to the scope of the audit.)
Situation: Due to recurring operating losses and working capital deficiencies, an auditor has substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. The notes to the financial statements do not adequately disclose the substantial doubt situation and the auditor believes the omission fundamentally affects the users' understanding of the financial statements.
Adverse
Situation: The client has changed from LIFO to FIFO for inventory valuation purposes; the auditors do not concur with this change. The effect is considered material and pervasive.
Adverse
Scenario: Predecessor auditors audited last year's financial statements and you audited the current year. You have decided not to ask the predecessor to reissue that audit report. Comparative financial statements are being issued on the two years.
Circumstance: Comparative F/S Type of Opinion(s): Unmodified Report Alteration: Other Alteration - No Paragraph Added
Scenario: Your client has declined to depreciate its assets this year because the depreciation expense would reduce the year's small income to a loss.
Circumstance: Departure from GAAP Type of Opinion(s): Qualified / Adverse Report Alteration: Basis for Modification Paragraph Added (both)
Scenario: Your client is a defendant in a major lawsuit. It is probable that the company will experience a material loss due to the lawsuit, although it is impossible to calculate the likely amount. The financial statements include a note adequately describing the matter. You decide that a standard report is inappropriate.
Circumstance: EMPH (Auditor Discretionary Emphasis of Matter) Type of Opinion(s): Unmodified Report Alteration: Emphasis of Matter Paragraph Added
Scenario: A client's financial statements follow GAAP, but you wish to emphasize that the client is a subsidiary of Webster Corporation in the audit report.
Circumstance: EMPH (Auditor Discretionary Emphasis of Matter) Type of Opinion(s): Unmodified Report Alteration: Emphasis of Matter Paragraph Added
Scenario: Due to a very major lawsuit, you have substantial doubt about a client's ability to continue as a going concern for a reasonable period of time. The financial statement disclosures related to this lawsuit are adequate.
Circumstance: Going Concern Type of Opinion(s): Unmodified / Disclaimer Report Alteration: Basis for Modification Paragraph Added / Emphasis of Matter Paragraph Added
Scenario: You decide to take responsibility for the work of the component auditors who audited a 70 percent owned subsidiary and issued an unmodified opinion. The total assets and revenues of the subsidiary are 5 percent and 8 percent, respectively, of the total assets and revenues of the entity being audited.
Circumstance: Group Audit Type of Opinion(s): Unmodified Report Alteration: No alteration
Scenario: You decide not to take responsibility for the work of the component auditors who audited a 70 percent owned subsidiary and issued an unmodified opinion. The total assets and revenues of the subsidiary are 5 percent and 8 percent, respectively, of the total assets and revenues of the entity being audited.
Circumstance: Group Audit Type of Opinion(s): Unmodified Report Alteration: Other Alteration - No Paragraph Added
Scenario: In auditing the long-term investments account of a new client, you are unable to obtain audited financial statements for the investee located in a foreign country. You conclude that sufficient appropriate audit evidence regarding this investment cannot be obtained.
Circumstance: Scope Limitation Type of Opinion(s): Qualified / Disclaimer Report Alteration: Basis for Modification Paragraph Added (both)
Which of the following circumstances generally results in the issuance of a report that is other than unqualified?
Circumstances have significantly limited the scope of the auditor's procedure
Situation: A client does not count its year-end inventory. The auditors are unable to obtain sufficient appropriate audit evidence related to inventory and they consider inventory as representing an extremely substantial proportion of the financial statements.
Disclaimer
Situation: Client-imposed restrictions significantly limit the scope of the auditors' procedures, and they are unable to obtain sufficient appropriate audit evidence. The possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive.
Disclaimer
Situation: The client has changed from LIFO to FIFO for inventory valuation purposes; the auditors concur with this change. The effect is considered material to the financial statements, although inventory is not a large part of total assets.
EMP
An audit report for a public client indicates that the financial statements were prepared in conformity with:
Generally accepted accounting principles (United States) (An audit report for a public client indicates that the financial statements are presented in conformity with generally accepted accounting principles (United States). The PCAOB does not issue accounting standards.)
When an auditor of financial statements has substantial doubt about an entity's ability to continue as a going concern, the auditor most likely would express a qualified opinion if:
Information about the entity's ability to continue as a going concern is not disclosed in the financial statements
Situation: An entity discloses certain lease obligations in the notes to the financial statements. The auditor believes that the failure to capitalize these leases is a departure from generally accepted accounting principles and, although the possible effects on the financial statements of the misstatements is material, they could not be pervasive.
Opinion: Qualified Report Alteration: Add a basis for modification paragraph—prior to opinion paragraph.
Situation: In auditing the long-term investments account, an auditor is unable to obtain audited financial statements for an investee located in a foreign country. The auditor concludes that sufficient appropriate audit evidence regarding this investment cannot be obtained.
Opinion: Qualified or Disclaimer Report Alteration: Add a basis for modification paragraph—prior to opinion paragraph.
Situation: Due to recurring operating losses and working capital deficiencies, an auditor has substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. However, the financial statement disclosures concerning these matters are adequate. The auditor has decided not to issue a disclaimer of opinion.
Opinion: Unmodified Standard Report Alteration: Add an emphasis-of-matter paragraph—after opinion paragraph.
Situation: A group auditor decides to take responsibility for the work of a component CPA who audited a wholly owned subsidiary of the entity and issued an unmodified opinion. The total assets and revenues of the subsidiary represent 17 percent and 18 percent, respectively, of the total assets and revenues of the entity being audited.
Opinion: Unmodified Standard Report Alteration: Issue standard report without alteration.
Situation: An entity changes its depreciation method for production equipment from straight-line to a units-of-production method based on hours of utilization. The auditor concurs with the change, although it has a material effect on the comparability of the entity's financial statements.
Opinion: Unmodified Standard Report Alteration: Add an emphasis-of-matter paragraph—after opinion paragraph.
Situation: A client is issuing 2 years of comparative financial statements. The first year was audited by another auditor who is being asked to reissue her audit report. (Reply as to the successor auditor's report.)
Other
Situation: An auditor reporting on group financial statements decides not to take responsibility for the work of a component auditor who audited a 70% owned subsidiary and issued an unqualified opinion. The total assets and revenues of the subsidiary are 5% and 8%, respectively, of the total assets and revenues of the entity being audited.
Other
Situation: A client changed the depreciable life of certain assets from 10 years to 12 years. The auditor does not concur with the change. Confined to fixed assets and accumulated depreciation, the misstatement is not considered pervasive.
Qualified
Situation: London Company has material investments in stocks of subsidiary companies. Stocks of the subsidiary companies are not actively traded in the market, and the CPA firm's engagement does not extend to any subsidiary company. The CPA firm is able to determine that all investments are carried at original cost, but has no real idea of market value. Although the difference between cost and market could be material, it could not have a pervasive effect on the overall financial statements.
Qualified
Situation: The auditors believe that the financial statements have been presented in conformity with generally accepted accounting principles in all respects, except that a loss contingency that should be disclosed through a note to the financial statements is not included. While they consider this a material omission, they do not believe that it pervasively affects the financial statements.
Qualified
Situation: A client uses the specific identification method of accounting for valuable items in inventory, and LIFO for less valuable items. The auditor concurs that this is a reasonable practice.
Standard Unmodified
When the matter is properly disclosed in the financial statements, the likely result of substantial doubt about the ability of the client to continue as a going concern is the issuance of which of the following audit opinions?
Qualified - No Unmodified with Emphasis of Matter - Yes (Substantial doubt about a client's ability to continue as a going concern results in either an unqualified report with explanatory language or a disclaimer of opinion. Accordingly answer (3) is correct since a qualified report is not appropriate.)
A change in accounting principles that the auditors believe is not justified is likely to result in which of the following types of audit opinions?
Qualified - Yes Unmodified with Emphasis of Matter - No (When an unjustified change in accounting principles occurs, either a qualified or adverse opinion is appropriate as this represents a departure from generally accepted accounting principles. Accordingly, answer (2) is correct since an adverse opinion, but not a disclaimer of opinion is appropriate.)
Situation: A client changed its depreciation method for production equipment from the straight-line to a units-of-production method based on hours of utilization. The auditor does not concur with the change.
Qualified or Adverse
Situation: A client's financial statements follow GAAP except that they do not include a note on a significant related party transaction.
Qualified or Adverse
Situation: A company valued its inventory at current replacement cost. While the auditor believes that the inventory costs do approximate replacement costs, these costs do not approximate any GAAP inventory valuation method.
Qualified or Adverse
Situation: Draves Company owns substantial properties that have appreciated significantly in value since the date of purchase. The properties were appraised and are reported in the balance sheet at the appraised values (which materially exceed costs) with related disclosures. The CPAs believe that the appraised values reported in the balance sheet reasonably estimate the assets' current values.
Qualified or Adverse
Situation: In auditing the long-term investments account of a new client, an auditor finds that a large contingent liability exists that is material to the consolidated company. It is probable that this contingent liability will be resolved with a material loss in the future, and this amount is reasonably estimable as $2,000,000. Although no adjusting entry has been made, the client has provided a note to the financial statements that describes the matter in detail and includes the $2,000,000 estimate in that note.
Qualified or Adverse
Situation: Slade Company has material investments in stocks of subsidiary companies. Stocks of the subsidiary companies are actively traded in the market. Management insists that all investments be carried at original costs, and the CPA firm is satisfied that the original costs are accurate. The CPA firm believes that the client will never ultimately realize a substantial portion of the investments because the market value is much lower than the cost; the client has fully disclosed the facts in notes to the financial statements.
Qualified or Adverse
Situation: An auditor was hired after year-end and was unable to observe the counting of the year-end inventory. She is unable to apply other procedures to determine whether ending inventory and related information is properly stated.
Qualified or Disclaimer
Situation: During the audit of Eagle Company, the CPA firm has encountered a significant scope limitation relating to inventory record availability and is unable to obtain sufficient appropriate audit evidence in that area.
Qualified or Disclaimer
In an audit report on combined financial statements, reference to the fact that a portion of the audit was performed by a component auditor is:
Report is delivered to the client. (Reference to the work of a component auditor is not, in itself, a qualification of the group audit report. This reference does not lessen the auditors' collective responsibility. Rather, it merely divides this responsibility among two or more CPA firms.)
Situation: A client changed from the method it uses to calculate post employment benefits from one acceptable method to another one. The effect of the change is immaterial this year, but expected to be material in the future.
Standard Unmodified
Situation: An auditor reporting on group financial statements decides to take responsibility for the work of a component auditor who audited a 70% owned subsidiary and issued an unmodified opinion. The total assets and revenues of the subsidiary are 5% and 8%, respectively, of the total assets and revenues of the entity being audited.
Standard Unmodified
Situation: An auditor was hired after year-end and was unable to observe the counting of the year-end inventory. However, she was able to apply other procedures and determined that ending inventory and related information is properly stated.
Standard Unmodified
Situation: In auditing the long-term investments account of a new client, an auditor finds that a large contingent liability exists that is material to the consolidated company. It is probable that this contingent liability will be resolved with a material loss in the future, but the amount is not estimable. Although no adjusting entry has been made, the client has provided a note to the financial statements that describes the matter in detail.
Standard Unmodified
A client has changed the salvage values of a number of its fixed assets. The auditors believe that the salvage values are realistic. The appropriate report on the financial statements is:
Standard Unqualified
An audit report for a public client indicates that the audit was performed in accordance with:
Standards of the Public Company Accounting Oversight Board (United States) (An audit report of a public client indicates that the audit was performed in accordance with standards of the Public Company Accounting Oversight Board (United States))
What is the objective of auditor reporting responsibilities with respect to consistency?
To give assurance that users will be informed of the lack of comparability of financial statements between periods due to changes in accounting principles.
Situation: Due to recurring operating losses and working capital deficiencies, an auditor has substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. The notes to the financial statements adequately disclose the situation.
Unmodified with an Emphasis of Matter Paragraph or Disclaimer
Situation: Due to recurring operating losses and working capital deficiencies, you have substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. The notes to the financial statements adequately disclose the substantial doubt situation.
Unmodified with an Emphasis of Matter Paragraph or Disclaimer
Jones, CPA, accepts a new client late in Year 5 and therefore had no opportunity to observe the physical inventory taken at December 31, Year 4. Jones found it impossible to obtain evidence by other auditing procedures as to the beginning inventories for Year 5. Jones observed the physical inventory at December 31, Year 5 and completed the audit satisfactorily. The report to be issued should:
be unmodified as to the balance sheet and with a disclaimer of opinion as to the income statement and the statement of cash flows.
Which of the following does NOT ordinarily involve the addition of an emphasis of a matter paragraph?
part of the audit has been performed by other auditors
If the auditors indicate in the report that the opinion is based, in part, on the report of component auditors who were responsible for the audit of part of the total financial statement data, the auditors are:
properly indicating a division of responsibility, and the report should further indicate in an appropriate quantitative form the proportionate responsibility being assumed by each set of auditors.
If the auditors believe that related party transactions are not adequately described in the notes to the financial statements, they should:
qualify their opinion or issue an adverse opinion.